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Congressional Stalemate Could Disrupt Multi-Year Contracts

Just as the Pentagon has asked for authority to put five programs on contracts that will run for up to four years, budget turmoil on Capitol Hill threatens to throw a wrench into the Pentagon's plan to save money and add stability to the industrial base on those and other long-term contracts.

Defense contracting specialists have argued that the Pentagon's vast industrial base would run more smoothly with multi-year contracts and save taxpayer dollars. That is a powerful argument, especially in today's current tight fiscal environment. But members of Congress have in the past been leery of granting multi-year contracts because they limit the ability of lawmakers to make changes in the future. This year, the debate is more than merely rhetorical.

By the end of September and the close of the fiscal year, Congress is unlikely to approve annual spending bills, instead proceeding with a six-month continuing resolution to keep the government running by extending programs included in last year's bill. That puts the Pentagon's request to buy Boeing CH-47 Chinook helicopters, V-22 Osprey tilt-rotor aircraft or extend by one year an existing contract for F/A-18E Super Hornets in limbo. The military has also asked to buy Virginia-class attack submarines on a contract running from fiscal 2014-18. The current multi-year purchase of the SSN-774 subs runs out in fiscal 2013.

Unless Congress agrees to a special exception to allow the start of those procurement efforts, contractors will either have to wait for a fiscal 2013 bill to pass, or sign a one-year contract and come back with the multi-year request for 2014. Congressional aides are increasingly pessimistic about whether fiscal 2013 spending bills will pass at all, regardless of who is elected president in November. Existing multi-year agreements are likely to be able to navigate the continuing resolution, say industry officials and analysts.

Multi-year contracts also could be derailed by a potential across-the-board budget cut that will take place unless lawmakers replace a law currently on the books. With the presidential campaign in full swing, few expect Congress will avert the penalty for failing to reduce the deficit—known as sequestration—before the election.

If it does take effect, sequestration will cause “deep legal uncertainty,” and will likely cause the government to pay more for less, says Richard Aboulafia, vice president of analysis for the Teal Group. Sequestration may not cause the cancelation of multi-year programs, but a 2004 effort to scuttle the multi-year purchase of Lockheed Martin C-130J aircraft created a legal headache for the Pentagon, he says.

Todd Harrison, defense analyst at the Center for Strategic and Budgetary Assessments, says sequestration could prompt the government to renegotiate contracts, which would drive up the unit costs for programs. Defense procurement will have a bit of a cushion from sequestration, though, Harrison says, because the Pentagon does not spend all of its budget authority right away. “For procurement and R&D it will take three or four years before the 10% reduction in budget authority becomes a 10% reduction in outlays,” he says.

In July, Sikorsky signed an $8.5 billion contract with the U.S. Army and Navy for 653 UH-60 Black Hawk and MH-60 Seahawk helicopters to run through the end of 2017. The multi-year agreement was approved by Congress in fiscal 2012.

Such large-quantity contracts typically have a minimum and maximum buy per year. It is possible a 10% reduction in the requested amount could still cover the minimum and avoid renegotiation. If sequestration causes the Pentagon to miss that minimum, however, penalties would result, says an industry official.

Harrison cautions that multi-year programs with limited quantities, such as the one granting the Navy the ability to make two Virginia-class submarines per year, could be even more difficult. “[The Navy] won't have the money to obligate the money on those contracts for two subs,” Harrison says. “And you can't buy 1.8 subs.”

Yet a Congressional Research Service (CRS) report on “government procurement in times of uncertainty,” indicates the Pentagon may be able to do just that by slowing work on certain awards. Many government contracts include “changes clauses” that allow the government to reduce the scope of its contracts, the report points out.

A separate CRS report on the Navy's Virginia-class submarine program outlined both the benefits and the risks of the upcoming multi-year request. The Pentagon estimates it could save $3.8 billion or about 13.8%. But the report, issued in April 2012, notes that “skeptics could argue that in light of current uncertainty over future levels of defense spending, it would be risky to enter into a commitment to procure a certain minimum number of Virginia-class submarines over the next five years,” writes CRS analyst Ronald O'Rourke. “Annual contracting, although more expensive than using [a multi-year program] arrangement, would give policymakers more flexibility for making changes in Virginia-class procurement rates in response to potential future reductions in defense spending.”

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